There is still much we don’t know about the virus. The biggest question mark is the mortality rate, commonly estimated by most health authorities at 2-2.5%.
We have accurate statistics on the numerator, thenumber of people who die from Covid-19 (hospital statistics), but very unreliable information on the denominator, the number of people infected, which is massively under-reported. In most countries, only symptomatic cases are being tested, and even that is not always the case.
If many more people are infected than realized, we reach herd immunity faster than expected. That does not take away from the reality that there will likely be hundreds of thousands if not millions of people dying in the coming months from Covid-19 in the US and Western Europe.
Not to minimize the humanitarian devastation caused by Covid-19: we suffer over a million deaths from each of car accidents and regular flu every year, yet the world economy does not miss a beat. It is lack of preparation and poorly thought out strategies of Governments that magnify the economic damage.2 So where do financial markets go from here? My own belief is that the partial recovery of equity markets last week was a classic “dead cat bounce.” The good news from last week’s massive monetary and financial stimulus caused the bounce, but the stimulus is already fully priced into markets. The coming bad news is probably not. It is unlikely that the Fed’s monetary and fiscal bazookas will solve the economic devastation caused by the virus, nor quell the panic and disruptions from loss of life. It can only provide some relief through liquidity. Over the coming months, the combined effect of death toll, lockdowns, associated panic, and unforeseeable knock-on or domino effects, will likely take market indexes lower, possibly significantly lower.
When looking at domino or knock-on effects, just the existing damage done to the global economy and financial system to date has the potential to unleash mass bankruptcies (restaurants, hotels, etc.). What about the ability of the Italian banking system to withstand the lockdown? To what extent will supply chains fail in this period of reverse globalization? A country hostile to the US taking advantage of its weakness, going on a land grab or starting a regional war? The possibilities are endless. We have no way of knowing what these domino effects may be, and they are not priced into markets. In my opinion, all bets are off. We are in a financial and economic storm without a compass. There is nothing financial markets dislike more than uncertainty. Asset allocation in these challenging times So how should assets be allocated over the coming months?
Cash. If you can afford it, have enough cash on hand to cover personal or corporate overheads for several months– a form of insurance.
Gold. Gold is the classic “safe haven” asset. While it sold off during the recent market crash, this was probably due to margin calls and a massive need for liquidity. Gold may be positioned for a breakout in the coming weeks. I personally have one third of my modest portfolio in gold-related assets: 10% of that in physical gold (coins), 30% in gold mining shares, 10% in a gold ETF, and 50% in gold royalties (Franco Nevada, FNV).
Debt. There is a distinct possibility that massive amounts of stimulus will lead again to inflation. As interest rates tend to rise during inflationary periods, to the extent you need debt, try to shift your debt to fixed interest rate debt. During periods of flight to quality, further appreciation of US Dollars, Swiss francs, etc., may be expected. Holding debt in emerging market currencies would likely be better.
Equities. As mentioned, bad news will likely outweigh good news over the coming months, causing equities to trend lower. Domino effects may severely effect certain types of equities (e.g. banks). Nevertheless, the most astute investors will be able to find winners in this difficult environment. Look at Amazon hiring 100,000 workers, or companies engaged in viral drug research.
Massive fiscal and monetary stimulus may very well reignite inflation in the medium to long-term. This reinforces the rationale for gold, and suggests we not hold too much cash. Long-term fixed rate debt, particularly in weak currencies, may well deflate in value over time should inflation kick in.
Our next blog will deal with the M&A environment in this coronavirus era.
Information, data, and analysis in this article shall not serve as advice to any investment decision. Neither Euro-Phoenix Ltd nor any of its officers and directors make any representations or warranties, express or implied, as to the validity and/or accuracy and/or completeness of the information set forth in this article.